Wednesday, 1 February 2023 — Albert Park

By Jim Rickards Editor, The Daily Reckoning Australia

[7 min read]

Dear Reader,

China is in a unique position among major economies of having low inflation and low interest rates. The Chinese economy has slowed down considerably in the past year and may already be in recession, although the official data obscures that reality.

Part of this slowdown is due to the breakdown of global supply chains, reduced demand from foreign buyers of Chinese goods in Europe and North America, and the damage from the real estate collapse in China.

Still, a large part of the economic slowdown is self-inflicted damage from China’s misguided and absurd ‘Dynamic Zero’ COVID policy in reaction to the pandemic. This is a major factor in the global slowdown.

We’ve written extensively about China’s ‘Dynamic Zero’ COVID policy in other contexts. Today, it’s wrecking China’s economy. Still, the story keeps getting worse and demands our time and attention.

The ‘Dynamic Zero’ COVID policy was invented by Communist Party Chairman Xi Jinping. The policy relies on public health officials, city officials, police, and Communist Party cadres for its full implementation. Under the policy, a single case of COVID can result in an entire building being placed under quarantine. Multiple cases in a single neighbourhood will result in the entire section of a town being placed under quarantine. More than 10 cases or so can result in an entire city being locked down.

This applies to the biggest cities in China, including Shanghai (population 26 million) and Beijing (population 22 million). These lockdowns are more than an inconvenience — they’re extreme. Tens of thousands of those in contact with the infected are physically relocated to COVID concentration camps on the outskirts of the cities. Anyone seen on the streets without permission is arrested on sight.

Transportation linkages into and out of the cities are shut down except for the few who have special permission to travel. For those allowed out to perform essential services, testing centres are set up on street corners every few blocks, and tests are administered daily.

No sooner does one city come out of a lockdown than another city becomes the victim of a new lockdown. China says this is all necessary to ‘defeat’ the virus. But that’s absurd. The SARS-CoV-2 virus that causes COVID is highly infectious and is airborne, so it goes where it wants. No amount of testing or lockdowns will stop the spread. The official Chinese vaccine from Sinovac doesn’t stop infection or the spread of the disease (neither do the Pfizer or Moderna vaccines we use), so that’s not a factor.

The real problem is that the Chinese haven’t reached the stage of herd immunity. The best vaccine is the disease itself. Cases are usually mild or asymptomatic and the antibodies that result from actual infection are the best defence against getting the disease again or spreading it. Since the Chinese use extreme lockdowns instead, they don’t achieve herd immunity and they can’t get past the pandemic in the way that the US, Europe, and others already have.

China is destroying its economy in this losing game of Whack-a-Mole. Factories are closed during lockdowns, supply chains are disrupted by shutdowns in transportation lanes, and productivity is crushed by the time spent in lines for testing or in concentration camps.

Why does China persist in such a pointless and costly effort? The unspoken reason is that Chairman Xi is scheduled to be appointed to an unprecedented third term as President this November at the 20^th National Party Congress. Xi doesn’t want to admit defeat by COVID and doesn’t want to embarrass himself by admitting his policy was wrong. So he persists at great cost. This is how ideology trumps science and common sense. The losers are the Chinese people — and investors in China.

[Note: Today’s article was originally published in July 2022.]

United Kingdom (UK) — depreciating the pound

The UK is high on the list of high-rate, high-inflation developed economies as shown in the charts above. The expected policy path is similar to the US, with two important differences.

The UK has already raised interest rates from 0.25% to 1.25% in the past six months, roughly the same as the US. But now the Bank of England has signalled they may raise at a slower tempo going forward. While the Fed has already signalled a 0.75% rate hike at its July meeting and possibly beyond, the BoE has indicated that future rate hikes may be only 0.50% or less.

This makes sense. If rate hikes are going to lead to a hard landing in terms of demand destruction and recession, then slightly lower rate hikes have a better chance of achieving a soft landing consisting of reduced inflation without a sharp recession. In fact, the UK may already be in a recession, but early indicators show that it may be mild. April GDP was only 0.4% below January’s GDP, a better performance than the US.

The UK also has a secret weapon not available to the US. This is depreciation of their currency against the US dollar, another example of the classic currency war strategy. The pound is down 14% from its post-Brexit high in 2021 and is close to the bottom of its six-year trading range at $1.22. A further depreciation, which seems likely, would give UK exports (and tourism) a boost and possibly avoid a hard landing even if a mild recession-style soft landing is already in the cards.

Japan — a yen problem

Japan is like China in the sense that it doesn’t fit the high inflation/high interest rate pattern of the rest of the major economies. Inflation in May 2022 was only 2.5%, and interest rates as of June were negative 0.10%.

Still, that level of inflation is high by Japanese standards; Japan has been in eight recessions in the past 30 years — really, it’s been a long depression, with persistent deflation rather than inflation.

Based on that situation, one would expect that the Bank of Japan (BoJ) will raise interest rates, however slightly, to slow the rate of inflation. Alternatively, the BoJ could raise the cap on yields on 10-year Japanese Government Bonds (JGBs) by buying fewer bonds and letting intermediate-term rates rise slightly. This policy is what the BoJ calls Yield Curve Control or YCC.

In fact, Japan will do neither. The reason is idiosyncratic to the system of Japanese finance and government.

The Governor of the Bank of Japan is Haruhiko Kuroda. His term as head of the BoJ ends in April 2023. He’s 77 years old and is the longest-serving head of the BoJ. Kuroda is unlikely to be reappointed and is now planning to retire as of next April. He’s looking forward to what the Japanese call ‘amakudari’ or the ‘descent from heaven’, which describes retirement from a senior government job. The retiree can look forward to a remunerative post-retirement with appointments to think tanks, institutes, and private company boards.

Kuroda is literally counting the days. If he makes any important policy moves, he has very little upside and enormous downside if his moves trigger a market panic or financial crisis. So, he’ll do nothing to jeopardise his ‘amakudari’. Kuroda will leave monetary policy to his successor.

That makes forecasting the Japanese economy extremely straightforward, at least in the short run. Kuroda will not raise interest rates. He will continue YCC by buying as many JGBs as necessary to keep a lid on intermediate-term rates. With both forms of monetary ease in play, inflation will increase slightly. The biggest impact will be a continued extreme decline in the exchange value of the yen, another form of monetary ease, and another facet of the currency wars.

Keep an eye out next Wednesday for the fourth and final part of this series of articles.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here. 

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

Last week ended on a grim note.

The US’s disposable income dropped by more than US$1 trillion. This was the second largest drop since the Great Depression. And the ‘inflation tax’ paid so far by American families during the Biden years, totals US$7,400 per household.

That is bad news. But who cares? You destroy a nation, first with inflation…then with war. The US elite is working both angles. Last week, it pledged to send 100 US tanks to Ukraine…prolonging the war…and getting itself in deeper.

This was heralded as a ‘game changer’ for Ukrainian forces. We know nothing about military matters. Still, we can’t help but notice a familiar pattern. Just as a summer leaf dries up in the autumn…and the old duffer forgets where he left his car keys…so does a great power become a not-so-great power.

Fraud and force

Our beat here is money. But money woes often come in a ‘cluster’ of other troubles. In our opinion, the introduction of the fake US dollar — in 1971 — was really the beginning of the US’s great decline (probably between #5 and #6 below). Fish gotta swim, birds gotta fly…and great empires gotta decline somehow. Typically, they do it with a combination of fraud (inflation) and force (war).

As for war…the elite is doing its best to keep the war in Ukraine going as long as possible…and to prepare the public for war with China.

Meanwhile, back on the inflation front, as we saw last week, the Fed is in a rare phase of returning to ‘normal’. Higher rates are squeezing the extravagance out of the financial markets…forcing the middle class to pay more for mortgages…and generally making the rich less rich.

If this correction is allowed to continue, we can expect asset prices to fall further and interest rates to rise. This is what we call the ‘Primary Trend’. After four decades of boom, we expect at least a couple decades of bust. This would be a good thing for the middle class because it would stop inflation from stealing its wealth. Ordinary people benefit from ordinary, honest money, not from the Fed’s tricked-up currency.

But…don’t hold your breath.

In the first place, ‘The People’ don’t control the Fed. The elite do. And while the economy of the last four decades wasn’t very pleasant for the middle class, it was a charm for the elite.

And the more the Fed helps Mr Market to ‘correct’ the excesses of the past — that is, cause the rich to lose money — the more the elite are going to want a ‘pivot’.

This inevitably sets up a showdown. Between the feds and Mr Market…and between what is good for The People (the middle class) and what is going for the elite. It’s going to get confusing…muddled…contradictory. Prices will go up…but what will they mean? Will inflation erase the gains? Will we be making money or losing it?

For today, let’s stick with the ‘Decline and Fall’…

Seven stages of decline

The process is well documented by the connoisseurs of decline — such as Gibbon, Tainter, Spengler, and Sir John Glubb. It was Glubb who calculated the average lifespan of an empire; from ashes to ashes, he figured, it was about 250 years.

Glubb, known as Glubb Pasha, outlined the stages of an empire as follows:

1. The age of outburst (or pioneers).
2. The age of conquests.
3. The age of commerce.
4. The age of affluence.
5. The age of intellect.
6. The age of decadence.
7. The age of decline and collapse.

Which, of course, raises the question: where are we?

Typically, an empire aids in its own destruction…with excess expenses, complications, and corruptions…weakening its economy internally as other countries rise.

Since 1945, for example, the US has spent trillions of dollars on ‘defence’. But its safety was never in danger. Instead, it involved itself in ‘wars of choice’…standard practice for empires that are peaking out. There is nothing really at stake. So, the idea is to spend money, not to win wars.   

On Abrams tanks, for example. The Abrams is a huge, sophisticated machine. It was built to protect the profits of Chrysler Defense, not to defend the US. It would only make sense as a defensive weapon if we believed a foreign army could attack us on land…as in, Chinese hoards bursting across the 49^th parallel…or the Iranian Guards suddenly crossing the Rio Grande and advancing on Dallas. Neither of those things are plausible.

Iron and brass

Instead, the tank is sent far away, into one foreign quagmire after another. There, it serves its real purpose well. It inevitably breaks down and needs careful maintenance and high-tech repair…involving huge additional expense. Weighing 68 tonnes, it’s a monster headache for road repairs.  

Money is often a hindrance in warfare, not a help. It tends to buy weapons systems that are too complex…and command structures with too many overpaid consultants and too much top brass. Here’s a smallish description from the National Defense University Press:

‘There are approximately 900 Active-duty general/flag officers (GO/FOs) today of 1.3 million troops. This is a ratio of 1 GO/FO for every 1,400 troops. During World War II, an admittedly different era, there were more than 2,000 GO/FOs for a little more than 12 million Active troops (1:6,000). This development represents “rank creep” that does not enhance mission success but clutters the chain of command, adds bureaucratic layers to decisions, and costs taxpayers additional money from funding higher paygrades to fill positions.’

Yes, the leaf turns brown…and the empire prepares for its defeat!

Regards,

Bill Bonner,
For The Daily Reckoning Australia